How can a Member of a Limited
Liability Company still be held Personally Liable?
A member of an LLC can still be held personally liable for
many different types of claims, but they typically arise under
four different scenarios which are summarized as follows:
- Claims arising out of an act or omission by the member, such
as the member's own negligence, fraud or illegal act
- Claims
arising out of a contract, particularly one that was personally
guaranteed by the member
- Claims based on the concept of
"piercing the veil" of the LLC
- Liability for consenting to or
receiving a distribution in violation of the LLC's operating
agreement or the applicable LLC statute.
These claims are not a result of choosing an LLC as a form of
entity. All of these exceptions apply equally to shareholders in
corporations and, in fact, the exceptions were developed first
under corporate law.
Actions of a Member
Every member who actively participates in the business of the
LLC runs the risk that his action or inaction will result in
personal liability. This is particularly a risk of a service
business in which the members provide the key service. If you are
an electrician and you leave an exposed wire that electrocutes
someone, your LLC is not going to protect you.
Similarly, if you make promises about your product or service
that are not true, the first claim may be against the LLC for
breach of contract, but if the LLC cannot perform or pay damages,
the injured party may come after you for fraud or a similar claim
based upon your own action.
Even if you have an employee who committed the action, you may
not be out of the woods. If you personally hired the employee, the
injured party may have a claim against you for negligent hiring if
a reasonable person would not have hired that employee.
A special category of personal liability that may trip up a
member of an LLC is failure to pay payroll taxes to the IRS. To
protect these so-called "trust fund taxes," any person who had the
ability to prevent the non-payment can be personally liable for
the failure to pay these taxes. The IRS applies this provision
broadly, so if you had power to direct which bills got paid and
which didn't, you are probably liable.
Claims Based on Contract
Another, and probably more common, source of personal liability
for many small business owners is the voluntary assumption of
liability, usually by means of a personal guarantee. For many
small businesses, particularly new businesses with no credit
history, obtaining a loan without a personal guarantee is
virtually impossible. Landlords, too, often insist on a personal
guarantee, particularly if the lease requires the landlord to
incur costs such as build-outs that it expects to recoup over the
term of the lease.
Suppliers are sometimes more flexible on extending credit,
especially after the business is up and running. Getting payment
terms out of the gate, however, often requires a personal
guarantee.
Even when the creditor isn't seeking a personal guarantee, a
member of the LLC can inadvertently become a party to the contract
by failing to clearly note his role. If she signs her own name and
does not indicate that she is executing the contract on behalf of
the LLC, it is very likely that a court will hold her responsible
for the contract. Every contract should clearly indicate that the
party to the contract is the LLC (full name!) and should indicate
the role of the person who is signing (member or manager).
Piercing the Veil of the LLC
Even if a member avoids personal guarantees, he may find
himself liable to creditors of the business under a theory
developed under corporate law and known as "piercing the corporate
veil." Although the factors that courts look at vary to some
extent from jurisdiction to jurisdiction, the courts typically
look at whether there is a unity of interest and ownership such
that the separate personalities of the entity and the owner no
longer exists and whether to respect the distinction between the
owner and the entity would be an injustice. In almost all cases of
piercing the veil, there is either commingling or diversion of
assets. Some other facts that courts examine in corporate cases
include:
- Inadequate capitalization
- Failure to issue stock
- Failure to observe corporate formalities
- Nonpayment of
dividends
- Insolvency of the debtor corporation at the time
- Non-functioning of other officers or directors
- Absence of
corporate records
- Commingling of funds
- Diversion of
assets
- Failure to maintain arm's length relationships among
related entities.
For more information on our business lawyer
services in the Columbus, Ohio area, please complete our Consultation Form or call us at 614.488.2270.
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